Thursday, February 17, 2011

John Deere is forecasting that agricultural prices will be higher here in the US this year and this will lead to increased farmer income. How? Price elasticity and the total revenue test. As I show in Prin. of Microeconomics, when consumers of a good or service are price inelastic, higher prices lead to greater total revenues (sales revenue) for the firms selling that good or service. The reason is that if consumers are price inelastic (i.e. not sensitive to changes in prices) then as the percentage change in price increases, the percentage change in quantity demand will decrease, but by a lower amount. This means that farmers agricultural total revenue will (on net) increase due to the higher revenues from higher price outweighting the lower revenues from reduced quantity sold. Thus since agricultural products like corn and wheat tend to be price inelastic, higher grain prices result in higher total revenues. If farmers cost are not rising (which is unlikely due to higher grain prices) then the higher total revenues will yield higher profits (or incomes).